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Mind the gap


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Price gaps occur as traders views change during the period the market is closed overnight or over weekends. On the re-open of the market the first trade is considered the sum of all expectation at the time where after market news is factored in to the opening auction.

 

Many text books describe an opening gap as being a bullish sign that the buyers are out in force. This works as long as you know where you are in the price trend, and as no one knows what the future holds in price movement, then we can never know where we are in the trend. An observation lost on traders who insist on holding a losing position, believing it will return to profit. The flaw with this type of trading is if a position does return to profit the trader has now been rewarded for bad behaviour and will continue to hold future losing positions expecting the same outcome, until one day the position loss becomes an account loss.

Back to point, let’s take a look as gaps can be described as bullish gap open or a continuation gap and finally the exhaustion gap.

Then with chart analysis this market event can be tested, and depending on your time frame as a trader the results can be put to work to use as an entry tool to open a position and or capture profits.

For the longer view investor the end of a trend is often the gap down on open in larger time charts than just a daily view that most traders and investors use. These events often occur in a weekly chart time frame.

 

 3 Gap chart.png

 

On the left ANZ posted a weekly gap down in MAY 2015 that ended 6 years of gains.

The Weekly gap in FMG in March 2014 lead the price down to historic lows of December 2016

On the right, the daily gap down ended 8 years of gains in Credit Corp CCP. The chart of CCP also displayed a gap down on open on February 2nd that was followed by a 16% decline, until the primary trend resumed some four months later.

 

 

 

 

 

 intraday gaps.png

 

 

A short term look at Gaps as a trading opportunity.

For the short term traders gaps can be used a little differently and can offer an intimate trading strategy. By short term, I refer to traders that use intraday strategies up 1 or 2 days holding time.

The opening price gap can provide some excellent trading opportunities for the nimble short term trader on both the long and short side of the market. But it does requires some reverse thinking and action. From a text book point of view when a stock gaps higher on the open it is a sign of strength, buyers in control. But consider the different type of market participants, some being long term holders and others only trading for quick profits.

In example 1 we can see from the close trading period following (1) gapped open and sold back into the first range. The following trading period gapped open lower and traded back higher.

When taking a closer look at the detail in price charts, this phenomena is a regular occurrence, in fact an average of 30% of daily bars can offer this type of short term “doing the opposite trading opportunity.” In the example 1 the fluidity of movement can be seen from the high close of the first bar the gap open higher of the second bar and the follow on gap down of the 3rd bar, within this bar the sellers have lost control to the buyers closing it in the top 80% of the range. Using an intraday chart the example 2 at the right highlights using a the 1 hour time frame the Gap open sell and Gap open buy offer short term trading opportunities for the nimble intraday trader. Correct position sizing and stop losses must be used with this type of strategy.

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